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Investing In Africa: A Long-Term Growth Opportunity?

Summary Certain indicators point to an overvalued S&P 500. Prudent investors should consider more attractively valued indexes. Despite headwinds, Africa’s improving fundamentals suggest long term growth opportunities. As the new year begins to take shape, most investors have their attention squarely focused on the United States as the oasis of growth in a desert of underperforming national economies. Nevertheless, when we take a closer look at the key American stock market index, the S&P 500 (NYSEARCA: SPY ), it would appear that many market observers consider it to be overvalued. Some suggest that its blended P/E ratio of 17 is on the upper end of its historical normal valuation range since 2001, others warn that it is historically expensive relative to GDP and finally most point to the Shiller P/E which currently sits at 26.4, which is 59% higher than the historical mean of 16.6. Although it is difficult to make accurate broad valuation forecasts for a large collection of companies such as the S&P 500, such forecasts can be useful to the prudent investor. If we are willing to accept that many companies trading on the S&P 500 are trading at or above their fair value we may at minimum need to consider the possibility of a slowdown in broad index growth over the coming year. As such, the prudent investor may want to start contemplating other more attractively valued indexes. It would appear that such opportunities lie in Africa. Despite several headwinds such as the effects of the Ebola virus, civil unrest (Boko Harem), the slowdown in the global economy and the drop in the price of oil, Africa remains a resilient continent poised to record around +5% economic growth. In a recent report Yogesh Gokool, head of the AfrAsia Bank explains that this growth will be primarily driven by more foreign direct investments and remittances from non-OECD (Organization for Economic Co-operation and Development) countries that will continue to pour money into corporate acquisitions and large-scale infrastructure projects. Resource rich countries will continue to attract the lion share of FDIs into Africa yet with the drop in the price of oil and rising wages in Asia, manufacturing will also be a significant recipient. The other main driver of growth will be private consumption. In a recent report by the United Nations Economic Commission for Africa entitled African Economic Outlook 2015 it was found that private consumption in Africa is expected to accelerate by 0.5 percentage points to 3.8 percent in 2015 due to consumer confidence and the expanding middle class. Private Consumption and gross capital formation are expected to be key drivers of growth (click to enlarge) Data Source: UN-DESA, 2014 In addition, inflation should remain under control by 0.4 percentage points to 0.7 in 2015. Subdued inflation across economic groupings (click to enlarge) Data Source: UN-DESA, 2014 As for fiscal deficits, the current account balance is expected to decline but remain positive for oil exporting countries while the current account deficit may rise less than expected due to lower oil prices for oil importing countries. Moderating fiscal deficits expected in 2015 among country groupings (click to enlarge) Data Source: EIU, 2014 As mentioned above, certain downside risks could slow economic growth in Africa such as the effects of the Ebola virus, civil unrest (Boko Harem), the drop in oil and commodity prices and a global growth slowdown. Based on early assessments , the economies of Guinea, Liberia, Sierra Leone are experiencing significant hardship as public finances are strained and household incomes are dropping. Nevertheless, the economic impact is not as bad as some feared as the World Bank estimated that Ebola could cost the region as much as $32 billion and the real cost appears to only be a tenth of that figure. In fact, a positive impact of the outbreak seems to be the renewed urgency to reinforce basic public health systems in vulnerable regions. As for lower commodity prices, the negative impact on the continent’s growth may be offset as lower prices will help ease balance of payments pressures in food and energy importing countries while commodity exporting countries face lower export earnings. Furthermore, these commodity declines will serve to reaffirm the benefits of more diversified national economies. Finally, in the face of a potential global slowdown Africa should remain attractive as its economic fundamentals remain sound . Governance and macroeconomic management have improved. Investment in infrastructure, human and physical capital are increasing. Productivity, the middle class and diversified trade are all growing and finally a culture of entrepreneurship is being created. Conclusions Given the risks outlined above and my belief that stable growth in Africa is still a long way off, it may be better to describe investing in Africa as an opportunity for the enterprising investor rather than the prudent investor. Nevertheless, if you remain patient and take a long-term view of an investment in Africa, you may be interested in several ETFs which have African exposure and are currently trading near their 52 week lows. The first is the Market Vectors Africa Index ETF (NYSEARCA: AFK ), which allocates just over a quarter of its weight to developed market countries that do business in Africa. This allocation serves to reduce some of the fund’s exposure to the volatility of local African markets. The fund is heavily weighted to South Africa, Egypt and Nigeria with financials accounting for around 40% of the fund while materials and energy account for around 30%. The other ETF of note is the Guggenheim Frontier Markets ETF (NYSEARCA: FRN ). This fund invests in a collection of small, illiquid and risky markets with great growth potential known as frontier markets . These often high yielding markets have become an asset class in their own right and the fund’s exposure to Africa is only about 13%, with the rest allocated to other markets in Latin America.

Sri Lanka – Do The Elections Represent A Green Or Red Light To Investors?

Summary 2-term President Rajapksa loses despite calling election 2 years early. President Sirisena calls for National Government in ‘Rainbow Coalition’. China’s Economic Influsence likely to be reduced, but any shortfall likely to be made up from elsewhere. India likely to play a more prominent role in economic activity. The election is a milestone in Sri Lanka’s maturing democracy and may well represent a milestone in its economic progression. Background On Thursday January 8th 2015, Sri Lanka went to the polls in a Presidential election. This election had been called 2 years early by President Rajapaksa following evidence of declining support for a President that had once been hailed as a national hero . Indeed, his party’s previous dominance had allowed him to change the constitution and permit his seeking a third term. However, despite this wavering support, few expected him to actually lose the election. In the event, Maithripala Sirisena, a former health minister in Mr. Rajapaksa’s cabinet, won the election and was immediately installed as President. Whilst polls had shown the 2 candidates to be level pegging, this result remained shocking. It is thus necessary to consider whether this is evidence of a maturity in Sri Lankan politics or a dangerous change of course following a period of solid economic advance. The Election Despite rumors that elements of the police and army were intimidating anti-Government supporters prior to the election, the poll went ahead in a relatively peaceful fashion. Around lunchtime on the 9th, President Rajapaksa conceded defeat and left the Presidential Residence. That evening, President Sirisena was inaugurated as President and congratulations poured in on a smooth transition from the country’s neighbours and indeed from US Secretary of State Kerry . However, on January 11th, news emerged that the transition may not have been as smooth after all. An aide to President Sirisena announced that President Rajapaksa had approached the police and military seeking support to remain in office. An attempted coup was claimed . However, even if this is correct, the police and military refused to support Mr. Rajapaksa and a peaceful transition has been effected. It seems highly unlikely that Mr. Rajapaksa will make any further attempt to unseat his successor following his rejection by the security forces. Moreover, it is likely that this initiative will be used by President Sirisena and his supporters led by the United National Party (‘UNP’), as a way of pressuring Mr. Rajapaksa’s Sri Lankan Freedom Party (‘SLFP’) ahead of April’s parliamentary elections. From this perspective, it seems likely that the Rajapaksa family’s dominance of Sri Lankan politics (and indeed business life) is at an end. Winners and Losers The principle losers from this election are the Rajapaksa family and China. It was no secret that members of the Rajapaksa family had benefited from their family connection to the President. Whether by holding official office or by their involvement in business deals, the ‘first family’ had clearly benefited. One of the first questions private equity or strategic investors made was which part of the family would be involved and what their expectations would be. Their involvement in the country’s business life cannot be removed overnight. A comparison may be made with some of the business associates of President Suharto of Indonesia whose influence certainly waned following his removal from office, but didn’t disappear. However, it is equally clear that Mr. Rajapaksa’s loss was at least partially owing to discontent with the nepotism that had marked his rule. Many of the transactions in which they had been involved were with Chinese investors . Indeed, a simple overview of Sri Lanka’s international relations during President Rajapaksa’s rule involves China supplying the armaments and finance required to extinguish the LTTE and in return being given a prominent role in the country’s economic expansion. Whilst this certainly involved providing access to money and equipment that has propelled the rebuilding of Sri Lanka’s infrastructure at a rapid rate, critics pointed to the Chinese investment as being a quid pro quo for securing a naval base in the Indian Ocean. Such Chinese involvement naturally put pressure on Sri Lanka’s relationship with neighbouring India. President Sirisena has already talked about China being a good friend to Sri Lanka but warned about not being behoven to any one nation. Additionally, his election manifesto included the cancellation of the Colombo Port City project, a US$1.3 billion project to reclaim land and build everything from high rise offices and apartments to a Formula 1 Grand Prix track. If he carries out these promises, it is clear to annoy China on both economic and strategic grounds. Indeed some have hailed the defeat of President Rajapaksa as destroying China’s overall Indian Ocean Foreign Policy and placing a dent in its ambitions to build a global network of ports. This is likely to be exaggerating things a little, at least at this stage. It is easy to point to India as being the strategic winner from this election. It understandably held concerns about China’s influence both economically and militarily in Sri Lanka. Additionally, the economic policies of the ruling BJP are more in line with the UNP in Sri Lanka than they were with the more left wing Rajapaksa administration. Additionally, the religious minorities of Sri Lanka were solidly behind President Sirisena, and polls indicate that the size of their turn out was a major influence in his victory. Whilst President Sirisena and his key supporters are Sinhalese, it is likely that their policies will be more accommodative of minorities than had been the case with the previous administration. Hence his call for a ‘rainbow coalition’ Invest or Wait? Let’s consider the key questions at this time: · Will President Sirisena change economic course in Sri Lanka to the detriment of investors? o Highly unlikely. His key supporters (UNP) have a more pro-business posture than the SLFP and have been critical of policies (such as the land reform bill) that were deterring to foreign investors. · What will the impact be of cancelling the Colombo Port City project and the planned integrated resorts (casinos)? o The Port City was certainly a massive project and the construction and engineering would certainly have added to the local economy. However, there were major doubts about its ambition and viability. o Given recent revenue contraction in casinos from Macau to Singapore and the planned launch of casino based projects in many other East Asian countries, it is questionable whether building such projects in Colombo would have had a big impact on tourist arrivals and expenditure. Sri Lanka has a wealth of attractions for tourists and many would argue that it can continue to accelerate its tourism industry without resorting to gambling. · Are the upcoming Parliamentary Elections important? o President Sirisena has pledged to reverse the trend of increasingly centralized Presidential power that evolved during President Rajakasa’s terms and strengthen parliament. However, this may be the largest uncertainty given the composition of the coalition which supported his candidacy. o There is little doubt that this coalition was more ‘anti-Rajapaksa’ than it was ‘pro-Sirisena’. Equally, that Sirisena comes from the left-leaning SLFP but now is supported by the right-leaning UNP creates uncertainty. He talks of a “rainbow cabinet’ but this may turn out to be a more effective sound bite with echoes of Mandela than a sustainable coming together of previous enemies. o President Sirisena now has 3 months during which he must bring together elements of multiple parties into a coalition which will support him and demonstrate leadership prior to the election. This will require an impressive level of political maneuvering and only time will tell whether he can pull this off to create a balanced but effective government. The worst case scenario is for the coalition to fracture and leave him without a power base. o His Prime Minister, Ranil Wickremsinghe, was the driving force behind the selection of Mr. Sirisena and is the leader of the UNP. The day to day relationship between these two gentlemen is going to be critical as if Sirisena is regarded as being a puppet of the UNP, then the coalition could fracture rather easily. · Should we be concerned about China being annoyed? o In a word…’No’. Whilst there is little doubt that a return of Rajapaksa would have been China’s preference, they will not want to endanger their access to this strategically important island. Whilst the military benefits of Sri Lanka were often focused upon, the economic benefits of having a trans-shipment option that is lower cost and arguably more convenient to Singapore or Malaysia is also key to Chinese interests. o As mentioned above, this may also allow India and Sri Lanka to become friendlier, particularly given the friendship of Messrs Modi and Wickremsinghe. It would be no surprise if Mr. Modi was one of the first visitors to Sri Lanka, bringing with him promises of additional trade and support. · What about the response of other Countries? o The removal of Mr. Rajapaksa who was the architect of the crushing of the Tamils may bring Sri Lanka closer to its Commonwealth brethren as well as the US. This may well translate directly into expanded financial support as well as giving the country the ability to face the events that accompanied the ending of the civil war without being punished for retaining as President the architect of these events. o It is likely that international relations will improve under Mr. Sirisena and Sri Lanka may once again focus on promoting its many strengths rather than defend its recent history. Conclusion Whilst there are reasonable uncertainties about President Sirisena’s political leadership and his ability to build a sustainable coalition, the positives from this election exceed the doubts. International investment will be more balanced and strategic investors are less likely to be frozen out by preference for ‘first family’ initiatives or Chinese investment. Despite this, credit has to be given to President Rajapaksa for the great strides that Sri Lanka has made over recent years. The country now has a solid foundation of infrastructure including power generation and transportation from which it can build. In m y previous article , I argued that there were many reasons to be positive about Sri Lanka over the coming decade. I see no reason for concern that these reasons have been diluted and indeed believe that stronger growth can now be achieved. Today, Pope Francis arrives in Sri Lanka on an official Papal visit. The timing is appropriate as he will be being greeted by a President who has made reconciliation between religions a key issue. From this perspective, it is an effective ‘Christening’ of the new administration. Only time will tell whether President Sirisena will reward the electorate’s confidence, but the signs are positive and assuming that he can harness the spirit of co-operation and renewal that Pope Francis is certain to preach, the country is set for strong further growth. Investment options for prospective investors in Sri Lanka remain limited. The Ceylon Stock Exchange is small, illiquid and volatile. In essence, it is more of a private equity market for the time being. However, we believe that this will change over coming months as Sri Lanka focused investment vehicles emerge. To this end, emerging market investors should keep at least one eye on Sri Lanka given its strong potential.

Gross Shocks Conventional Wisdom

Bill Gross told investors this week to Beware the Ides of March, or the Ides of any month in 2015 for that matter. When the year is done, there will be minus signs in front of returns for many asset classes. The good times are over. Gross is the legendary bond fund manager who left the company he founded, PIMCO, for a job as a portfolio manager at Janus Global Unconstrained Bond Fund, so most people pay attention when he writes. The prediction came inside the January Investment Outlook for investors. But for the mainstream financial media, he might as well have expelled foul smelling gas at a crowded party. The media quickly pointed out how contrarian his forecast is. For example, the Bloomberg reporter wrote: Gross is putting himself way out on a limb: Not one of Wall Street’s professional forecasters predict the S&P 500 will drop in 2015. Their average estimate calls for an 8.1 percent rise. And while the global economy looks weak, the U.S. has been heating up, with GDP up 5 percent in the third quarter. Of course, he forgets that mainstream financial experts and economics have failed to see every recession for the past century, especially the latest. They have failed because their business cycle theory asserts that recessions and the stock market collapses that precede them are random events. In other words, @#$% happens! So while insisting that business cycles are random events and by definition unpredictable, they continue to insist they can predict them! Gross makes one mistake that shows the bad influence behavioral finance has inflicted on him. He wrote, Manias can outlast any forecaster because they are driven not only by rational inputs, but by irrational human expressions of fear and greed. Stock and bond market “bubbles” are not manias; humans are not irrational with their money and the current market levels don’t illustrate greed or fear. As my forecasts show, the stock market reflects historically high profits plus greater tolerance for risk by investors. And the bond market is responding rationally to the Fed’s loose monetary policy. Fortunately, Gross doesn’t follow mainstream economics. His rationale comes from the “debt super cycle.” Gross attributes the theory to the research and investment advisory firm Bank Credit Analyst, but the cycle has been a major theme of the Bank for International Settlements for years. You can find a good intro in Claudio Borio’s The financial cycle and macro economics: What have we learnt? In short, the theory says that debt increases when central banks pump money into the economy through artificially low interest rates and open market operations, that is, buying bonds, also known as quantitative easing. Much of the debt increases the value of capital that has been used as collateral on loans and makes further borrowing on the same collateral possible. Credit continues to expand, asset prices rise and GDP increases as part of the expansion phase until debt service burdens become too great for businesses or households to bear, causing them to cut back on spending. As a result, asset prices fall and banks demand more collateral for outstanding loans. Some companies default and the financial system spirals downward, taking the economy with it. The latest debt super cycle extended almost 20 years peak-to-peak, from about 1989 to 2007. Business cycles last up to 8 years, but when a recession coincides with a peak in the debt cycle, it’s much more severe. There is a lot of truth in the debt super cycle theory. But it doesn’t explain why debt service becomes unbearable. After all, if asset prices are increasing and the economy is growing, debt service should become easier. The debt theory needs the Austrian business-cycle theory to make it whole. Debt service becomes a burden when sales fall in the capital goods sector because sales are soaring in the consumer goods sector. This is Hayek’s Ricardo Effect kicking in. However, the debt theory helps flesh out some of the financial aspects of the ABCT. So what does Gross advise investors to do? He recommends buying Treasuries and high quality corporate bonds. He cautions that rising interest rates could hurt such investments, but if the debt cycle theory is correct, that won’t happen in 2015. Only contrarians like Gross make money when the market morphs from a bull to a bear.